Moneycontrol Pro Weekender: Saint Powell and the inflation dragon

If indeed the global economy continues to get better, that could provide a fresh tailwind for Indian equities.

Dear Reader,

The Bank for International Settlements (BIS) says in its quarterly report, published this week, that the gap between the market’s perception of interest rate cuts and the central bank projections has narrowed quite a bit. Claudio Borio, head of the Monetary and Economic Department at BIS, said at the press meet that it proved that the central banks’ views on inflation and rate cuts were closer to the mark.

Alas, he hadn’t reckoned with Jerome Powell. At his testimony before Congress, he let the cat out of the bag when he said the Fed was ‘’not far’’ from the point of cutting interest rates. That was all the markets needed to celebrate, and he followed that up by saying, ‘’Interest rates right now are well into restrictive territory. They’re well above neutral.’’ The upshot: The S&P 500 lost no time in making a new high, spurring another rally in global equities. For good measure, to those who thought that US fiscal expansion was the reason for loose financial conditions, he said, ‘’We’re a long way from the point of fiscal policy overwhelming monetary policy.’’ The result was that the markets are now pricing in a higher probability of four or more rate cuts by the US Fed by the end of 2024.

There are holdouts and kill-joys, of course, such as Torsten Slok, chief economist at Apollo Global Management, who said, in this interview, ‘’ the Fed probably turned dovish too quickly – and the consequence of turning dovish too quickly is that we’re now beginning to see the economy reaccelerate. For sure, the Fed will now begin to turn hawkish again over the next several months. In other words, we are not done fighting inflation.’’

In fact, the JP Morgan Global Composite PMI showed that global economic growth accelerated to an eight-month high in February.  The survey said, ‘’The rate of expansion was the fastest since last June, reflecting a further solid increase at service providers and the first gain in manufacturing new orders for 20 months. The trend in international trade volumes also moved closer to stabilising.” The title of the BIS quarterly report is ‘’Markets count on a smooth landing’’, but the data so far suggest the global economy is accelerating. Support for that view also comes from Chinese exports growing by a far better than expected 7.1 percent in January-February 2024, although that is in part due to increased exports to Russia.

If indeed the global economy continues to get better, that could provide a fresh tailwind for Indian equities. Dharmesh Kant, Head of Equity and Derivative Research at Cholamandalam Securities, told us in this interview that ‘’There is a fear that the markets could crack sharply given the swift run up, but there is not a single fundamental metric that is weak now: be it commodity prices, oil prices, forex reserve, the currency.’’ While most of the positives about Indian equities are already baked into prices, an export upturn may provide additional support. We wrote, for instance, that for auto companies, an export recovery is in sight. And for Shivalik Bimetal, ‘’As global markets recover and demand rebounds, Shivalik is poised to capitalise on emerging opportunities and drive sustained growth.’’

Another tailwind could come from global inflows into India’s bond markets, which will keep yields down. As this article says, India’s bond market is now in a sweet spot on strong flows, while this one says, ‘’ We believe index and strategic allocations could potentially result in ~USD 100 bn inflows (~USD 50 bn index related and ~USD 50 bn non-index strategic allocations) over the next 3-5 years while still keeping foreign investor proportion at just 8-9% of the market.’’

Of course, good times lead to pockets of overheating. For example, this interview points to the RBI’s discomfort with unsecured lending and says, ‘’Since improvement in the trinity of credit growth, credit cost, and net interest margins for banks is probably behind us, investors may find better opportunities elsewhere.’’ My colleague Aparna Iyer wrote that ‘’RBI’s crackdowns show chase for higher returns breeds callous lenders.’’ And this story pointed to muted advertising growth and said it reflects low consumption spending. The geopolitical dangers continue, as seen in the threat to undersea cables in the Red Sea, while the de-globalisation challenge is seen from the flop show at the latest WTO meeting.

There’s also the danger from the euphoria on small cap stocks. My colleague Ravi Ananthanarayanan analysed threadbare the financial health of smaller companies and found that ‘’smaller stocks are indeed doing well on some aspects, but there are enough red flags that should give investors pause for thought.’’ This interview discusses SEBI’s advisory on small cap funds, while our columnist Jayant Thakur argues that more measures may be needed.

And then there is China. In a closely argued piece titled ‘’China’s excess savings are a danger’’, the FT’s Martin Wolf says that China’s very high investment rate of 40 percent of GDP is no longer sustainable, especially given its property sector meltdown. But its savings rate remains very high, primarily because of households’ ultra-low share of China’s national income. Yet the Chinese government continues to ignore calls for increasing household consumption. In such a scenario, with savings much higher than investment, the country will run up a huge current account surplus, argues Wolf. But who will run the offsetting current account deficits? Wolf writes, ‘’Who, in particular, will run them when the concomitant rise in exports will be driven by investment in competitive manufactures, such as electric vehicles? The answer is not creditworthy high-income countries: they will view these as “beggar-my-neighbour” policies. The same will surely be true for big emerging economies, such as India. If China wants the mercantilist solution to excess savings it will have to fund smaller emerging and developing countries.’’ Two recent news items bear out Wolf’s analysis: one, this article, which says China’s investment in Asia rose 37 percent in 2023; and two, the EU move to slap retroactive tariffs on electric vehicles from China. It’s no wonder Mohamed El-Erian pointed out that global fund managers are viewing their purchases of Chinese equities as a trade, rather than as a long-term investment.

On the other hand, China’s much-awaited session of the National People’s Congress deflated stimulus hopes, which may be a good thing as it means lower commodity prices for the rest of the world and lower inflation.

The Bank for International Settlements warns, however, that the last mile on disinflation is not going to be easy. This article in its quarterly report says that inflation in services is likely to be persistent, because most services are not traded and because they are labour-intensive and labour markets are tight in developed economies. Its conclusion: “This means that, all else equal, services price growth may have to be much lower than it was in the decades that preceded the pandemic if inflation targets are to be achieved.” That will be a concern for the advanced economies, because services have the largest weight in their inflation gauges and GDP.

The markets, however, will be comforted that their champion, Jerome Powell, seems to be paying little attention to such grouchy messages. He firmly believes he will slay the inflation dragon. As Toto sang in St. George & the Dragon, Powell may well croon:

‘I can tell by the look in your eye

You'd better watch yourself, St. George is on his way’’.

Cheers,

Manas Chakravarty

Here are some of the other stories and insights we published this week, in case you missed them, apart from our technical picks in the equity, commodity and forex markets:

Stocks

Esaf Small Finance Bank, Engineers India, Transport Corporation of India, CSB Bank: Best proxy for growing gold loan business, Gopal Snacks IPO, ZEEL: Tough media environment weak investment case, RK Swamy IPO, CMS Info Systems, Tata Motors demerger, JG Chemicals IPO, Control Print,

Markets

Gold price to remain volatile after hitting record high, this is why

Is the craze for public sector bank stocks warranted?

Gas markets, OPEC’s production cuts and its diminishing impact on oil prices

What’s driving the Nikkei rally?

Financial Times

How trade can save the planet, one tedious spreadsheet at a time

The radical changes coming to the world’s biggest bond market

Companies and sectors

Why Suven Pharma’s investors are excited about Cohance Lifesciences

Tata Motors’ demerger offers investors a global car maker in JLR

Demerger caps a decades-long metamorphosis of Tata Motors

Inside Edge

Retail powers Polycab, did savvy HNIs escape unseasonal Rain, Salzer promoters in love with their stock, cold comfort for MFs

HNIs find Voltas cool despite tepid numbers, panic attack for Godfather’s friends, Desi Soros’s new address, new tycoon gets visa power

Tech & startups

Musk vs Altman and the OpenAI soap opera

Google vs Indian apps

Google vs Indian apps: Goliath vs David or just another business squabble?

Economics & policy

Falling cost, government incentives to fast-track rooftop solar installations

Pro Economic Tracker

Geopolitics and geoeconomics

Jaishankar’s two-nation tour a test for twin-track diplomacy

The Eastern Window: Japan searching for a balance between national security, economic ties with China

Others

Portfolio construction plays a crucial role in fund management

Marketing Musings: Differences between Gens X, Millennial and Z mean a unidimensional marketing strategy won’t work